Changes are likely for FHA insurance refunds

Reporting from Washington —

Homeowners who trade in loans insured by the Federal Housing Administration could be in for a big payday, and not just in the form of a lower interest rate and correspondingly lower payments.
If your old FHA loan is less than 3 years old, you will be getting back some of the insurance premium you paid at closing. But only if you take out another government-insured mortgage.
If you refinance into any other type of loan — one guaranteed by a private insurer, for example, or perhaps a conventional mortgage without any coverage at all — all that money you shelled out in advance for your original FHA mortgage will be gone forever.

And if recent history is any gauge, FHA borrowers who jump ship may soon not get any refund at all, even if their current loans have been on the books for less than 36 months, and even if they merely switch to a less expensive FHA loan.

That's pure speculation, of course. But FHA spokesman Lemar Wooley says the agency is "considering a different way to handle refunds." And the scuttlebutt on the street is that refunds could be eliminated altogether.

Wooley declined to provide any clues as to what the FHA has in mind, saying only that the issue would be addressed in a future letter to lenders.

But over the last decade, the government has gradually shortened the refund period, from seven years to five and then to the current three. And with the agency's main insurance fund reserves still dangerously below congressionally mandated levels, it could decide to end the refunds and keep the unused premiums to bolster its bottom line.

However, other sources believe that what the FHA has up its sleeve will benefit refinancers, not penalize them.

One possibility is that the FHA will opt to apply what it owes borrowers to the outstanding principal of their new loans. Or refunds could be credited against the closing costs of a new loan at settlement rather than mailed in a check at a later date.

Either of those scenarios could be helpful, especially because refunds may be substantial.

Say, for example, that you took out a $500,000 mortgage in California last February. Back then, the upfront insurance premium for an FHA mortgage was 2.25%, so you paid $11,250 in advance for the privilege of having Uncle Sam protect your lender in case your mortgage went into default.

Now you are refinancing that loan. If you close this month on your new loan, according to the agency's current refund schedule, you would get back 60% of what you originally paid, or $6,750.

That's not pocket change. And if the refund was applied to your new loan's balance instead of sent to you by check after closing, you would be borrowing less and, therefore, your new monthly payment would be somewhat lower than it otherwise would be.

The typical FHA refund isn't nearly that large. Wooley reports that the payout averages about $1,100. But even that small amount can be meaningful.

If it were applied as a credit against closing costs, for instance, it would mean that you would need less cash to settle on the new mortgage. And you wouldn't have to wait for the government to cut you a check. Currently, it takes the agency 30 days on average to process refunds, Wooley says.

It takes that long because your old lender must first notify the FHA that coverage has been terminated. Then the agency determines how much of the upfront premium will be refunded based on the number of months the loan was insured. And finally, the agency requests that the Treasury Department issue a check.

With today's technology, those steps shouldn't be terribly time-consuming. But the FHA is woefully behind the times electronically, so the process could take longer than 30 days. Much longer.

In fact, the FHA suggests that if you don't receive your money or an application for a refund within 45 days after you paid off your loan, you should check with your old lender to confirm it has sent a request to end coverage. And if you don't see anything in your mailbox after 120 days, the agency says to call its Washington headquarters at (800) 697-6967.

While the hope is that the FHA will decide to handle refunds in a more borrower-friendly manner, there is evidence to suggest the agency will turn into a post-holiday Scrooge and eliminate the rebates altogether.

That has been the course since 2000, when then-FHA Commissioner William Apgar, now a senior advisor on mortgage-finance matters to current Secretary of Housing and Urban Development Shaun Donovan, lowered the upfront insurance premium but shortened the refund period to five years from seven. (The FHA is a division of HUD.)

Then, in 2004, Congress not only trimmed the refund period to three years in an effort to shore up the sagging insurance fund, but it also ordered the FHA to end refunds except when the borrower refinances into another FHA-insured mortgage.

Consequently, it's not a big step to think FHA refunds could soon be a thing of the past. But we'll have to stay tuned to find out.